How to solve a problem like rebalancing?

No sign of any decline in geographic imbalances …

I wrote recently about the continuing imbalance in economic performance between the South of England and the rest of England and Wales. (Scotland also lags the South but I have considered this in a separate piece and focus on England and Wales here). The challenge is to identify what would really make a difference geographically for the whole country, which means for the towns and smaller cities that do even worse than their larger neighbours.

… as the differences are clear …

The analysis of relative city performance provides real insight into how policy and different industrial structures influence economic performance. As shown below, the strength of a city in professional services and ICT explains the majority of the differences in growth rates.

By contrast, manufacturing is negatively correlated with GVA growth. Cities with a strong manufacturing base find their expansion limited by the relatively slow growth of manufacturing compared to the services sector.

The performance of Reading, Cambridge and several other southern cities illustrates the importance of sectors in determining performance in the short to medium-term. In our latest Region and City report, we forecast that the GVA of information & communications and professional services will grow by 3.5% and 3.4% annually respectively over the next 3 years. By contrast, manufacturing will only grow by 1% over the period. This translates into strong performance for Reading, where the information & communications sector accounts for more than twice as large a share of GVA as the national average, and Cambridge where professional services account for 50% more of local GVA than the national average share. Over 50% of Cambridge’s growth in the next 3 years is forecast to come from ICT and professional services.

But it is also clear that location is not a binding constraint on growth. The strong GVA growth performance, both historic and projected, for Manchester reflects the substantial investments made over more than a decade in revitalising the city centre and the surrounding business infrastructure. This has allowed the city to strengthen and diversify its local economy and ensure it can capture growth waves and avoid being over-exposed to a slowdown in a single sector.

… and it gets worse, the deeper you look …

However, the success of Manchester and the strong southern cities highlights another challenge; the power of cities, especially the larger ones. When we compare our region and city forecasts it is clear that the strong are getting stronger. City growth typically outpaces regional growth which means that the towns and other areas within regions are growing more slowly. Geographic imbalances exist within regions as between them.

… and change is proving very difficult to achieve ...

In this context, we believe our economic forecasts for the UK’s regions and cities provide a lot of food for thought – not least for government policymakers seeking to stimulate a faster and more balanced pattern of growth across the UK, and for local, regional and city authorities seeking to claim their fair share of that growth. Our projection is that the North-South divide is set to widen very slightly over the next 3 years and imbalances within regions will continue to grow. The potential of targeted initiatives is clear but at the current pace, the drive for rebalancing will take years to have a noticeable impact.

… so time for a new push …

The Government has just published its proposals for the UK’s industrial strategy. We see this as an extremely positive development. It is also opportune, the world economy is changing and the UK has a once in a generation opportunity to reposition itself in a world of changing trade dynamics and technology led disruption.

… with sectors to the fore …

The analysis above highlights the central role of sectors as a key driver of local economic outcomes. The Industrial Strategy recognises the role of sectors but really only scratches the surface identifying a small number of sector deals. These initial deals need to be quickly extended to a wider range of sectors. As priorities it is important to address:

• Manufacturing remains a key element of the economy of many regions and cities of the UK, especially outside of the South East. The automotive resurgence in the Midlands shows what is possible and other capital intensive industries such as machinery, electronics, food and drink and chemicals all offer the opportunities to boost exports and to substitute imports, something that is more urgent following the fall in the value of sterling.
• It is clear that technology will be a key component of UK growth both within the information & communication sectors but also more broadly across other sectors of the economy and especially advanced manufacturing. Support for Artificial Intelligence is a good first step in the Industrial Strategy but a broader approach to digital sectors to include, amongst others, virtual reality, Fintech, analytics and 3D printing is essential.
• The Industrial Strategy identifies health and clean energy as challenges with opportunity. This is clear as both sectors have the potential to address areas such as clean energy and the pressure of ageing but could also form the basis for new industrial development. Given this potential, the scale of response appears some way short of that required to address such transformational activities.

… within a wider policy response …

The sector plans are just one area requiring further ambition. Other elements of policy must be designed to complement the industrial strategy. The key components of this policy should be:

• Devolution of economic policy making to make the increased support for Local Enterprise Partnerships (LEPs) set out in the Industrial Strategy a reality. If policy is to succeed it needs to be integrated and this means that more control and resource for skills and education, housing, infrastructure, transport and health care needs to be devolved to the local level. There is also a need to streamline local decision-making and establish clarity of leadership.
• A commitment to deliver infrastructure that has to go beyond the welcome first steps in the Industrial Strategy. A cross-country rail and road network fit for purpose in the North and Midlands are essential requirements. Broadband and mobile access also needs to be upgraded much more significantly and faster than provided for in the white paper to ensure all parts of the country are connected so that people can participate fully in the economy.
• Investment in the skills required to build a successful modern economy that is competing on the world stage. Digital skills will be a key part of this and the “Made Smarter” review provides an excellent framework on which to base policy.
• A regional trade strategy which links all the elements of UK trade in the context of the industrial strategy. The UK’s post-Brexit trade deals must guarantee access to the right markets for the right products and enable imports to the UK.
• The appropriate policy and incentive regime to allow the UK to reposition itself in existing markets and to create a platform for growth in new sectors. This should include further incentives for investment in R&D, tax and business rate schemes that incentivise capital investment, support for supply chain realignment and other initiatives such as using public procurement to de-risk corporate decision-making in an uncertain and challenging economic environment.

… commensurate with the scale of the challenge.

The UK has to view geographic rebalancing as a key component to the process of transforming the economy. We should not underestimate the scale of the challenge. As the recent EY ITEM Club special report on business investment identified, the UK has under-invested relative to our peers for a long period of time. With the requirements to prepare for Brexit, position for technological change and maintain our competitiveness, we need to invest more than we have done for some time. To achieve a level of business investment that puts the UK around the G7 average will require an increase of around ￡50bn a year. The Industrial Strategy is a good first step but more public resources will be required to create the economic platform necessary to stimulate the required level of business capital spending.

And rebalancing is a more significant challenge than considered to date. As identified above, imbalances exist at a local level as well as at the national level. Policy to date has concentrated on the core cities and national initiatives in the main but we need a bottom up approach to run in parallel with this, with the explicit aim of raising the level in the weakest parts of the economy, the UK’s small cities and towns.

Download the EY UK Regional Economic Forecast

@MarkGregoryEY

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